In this
case, the Court considers whether the Department of Education
(“DOE”) acted arbitrarily and capriciously with
respect to cosmetology schools when it decided to
presumptively use earnings data that does not account for
unreported income. Although the DOE was justified in using
reported income as the presumptive measure of overall income,
it arbitrarily and capriciously made rebutting that
presumption overly difficult.

In
setting standards that determine which proprietary
schools' graduates are entitled to federally backed
student loans, the DOE looks to the rates at which the
schools' graduates are “gainfully employed.”
To determine whether graduates are gainfully employed, the
DOE has adopted a test that compares the graduates'
income levels to their levels of debt. To determine the
graduates' income, the DOE presumptively uses the Social
Security Administration's (“SSA”) income
data. This data does not account for income that is not
reported to the Internal Revenue Service. Schools may appeal
the DOE's use of SSA data through “alternate
earnings appeals, ” which, if successful, allow them to
use alternate measures of income before the debt-to-earnings
rates become final. To submit such an appeal, a school is
required to use either state-sponsored data pertaining to
over half of its graduates during the relevant timeframe or
gather income data on almost all of its graduates through a
survey. Schools that fail the debt-to-earnings test for a
long enough time lose eligibility for federal loans. Schools
at immediate risk of losing federal-loan eligibility are
required to warn their students and prospective students that
they may be ineligible for student loans in the near future.

During
the notice-and-comment period, several commenters argued that
use of SSA data would be unfair to, among others, cosmetology
programs, because their graduates disproportionately
underreport their income due to high levels of cash-based and
self-employment-based earnings, including tips. The
commenters suggested that the Bureau of Labor
Statistics's survey-based data would better account for
unreported income.

The DOE
rejected the commenters' objection to the data and their
proposed solution. In rejecting the objection, the DOE
reasoned that graduates who do not report their income are
subject to civil and criminal penalties, and noted that the
SSA data is only one means of determining income; programs
can submit alternate earnings appeals to show the DOE that
its graduates' average incomes are actually higher than
the SSA data indicates. In rejecting the proposed solution,
the DOE noted that the Bureau of Labor Statistics data cannot
be tied to particular programs, and thus would undermine the
purpose of the regulations-to identify individual programs
whose graduates are not gainfully employed.

The
American Association of Cosmetology Schools
(“AACS”) sued under the Administrative Procedure
Act, arguing that these responses were unsatisfactory, and
thus the DOE arbitrarily and capriciously failed to
adequately consider the unreported-income issue when it
promulgated the regulations. AACS is a nonprofit association
of cosmetology schools, many of which are at risk of failing
the DOE's debt-to-earnings test. In fact, at least three
schools have already posted warnings to their students,
because they could not feasibly appeal their failing grades.
Defendant moves for summary judgment on two procedural
grounds and on the basis that the regulations were not
arbitrary or capricious.

Both of
the DOE's procedural arguments concern subject-matter
jurisdiction. It first argues that AACS does not challenge
final agency action, because none of AACS's
member-schools have unsuccessfully appealed their failing
debt-to-earnings rates. The DOE also argues that AACS does
not have standing to bring this action, because it did not
identify any individual member-schools with standing in the
complaint. The Court holds that AACS is challenging final
agency action, because at least three schools have already
had to post warnings, and raising an administrative appeal is
not a prerequisite to suit under the APA. The Court further
holds that AACS has standing to bring this case, because AACS
indeed identified adversely affected members and meets all
other requirements to establish associational standing to sue
on behalf of its members.

The DOE
argues that it did not act arbitrarily and capriciously
because it provided a reasoned explanation for its rejection
of commenters' concerns about unreported income and their
proposed solution. The Court holds that, although the DOE was
rational in rejecting the commenters' proposed
alternative, it did not adequately address the issue of
unreported income. Neither side disputes that SSA data is
highly accurate, even though it may be insufficient in
certain circumstances. But, as the commenters pointed out-and
the government did not dispute-there is a significant problem
with this data. Despite the illegality of failing to report
earnings to the IRS, many programs' graduates fail to
report substantial portions of their income. The DOE
proffered two responses to the commenters' problem.
First, it argued that civil and criminal penalties deter
underreporting. Second, it noted that institutions may submit
an alternate earnings appeal to have their graduates'
earnings more accurately calculated.

The
existence of penalties-which existed when the commenters'
data was collected and will continue to exist into the
future, absent some added deterrent-is irrelevant to the
issue of undercounting income. In comparison, an alternative
means of measuring earnings data is responsive to the
problem. The DOE justifiably used SSA data as the default
measure of earnings, but supplemented that default
methodology with an alternate means of determining income.
However, by inexplicably requiring high response rates to
submit state-sponsored or survey-based alternate earnings
calculations, the DOE narrowly circumscribed the
alternate-earnings appeal process, making it unfeasible for
certain programs to appeal their designations. To remedy the
DOE's arbitrary and capricious narrowing of appellate
recourse-and to avoid upending the entire administrative
scheme-the Court removes barriers to appeal, making it more
widely available for programs subject to the regulations.

II.
REGULATORY BACKGROUND

Congress
passed Title IV of the Higher Education Act of 1965
(“HEA”) to make postsecondary education more
widely available to the general public. See 20
U.S.C. § 1070(a). To broaden the availability of student
loans and lower their cost to students, Title IV authorizes
the United States government to enter into agreements with
postsecondary educational institutions to allow students at
their schools to obtain federally guaranteed loans. See
Id. § 1094. To protect the taxpayer, the government
sets certain conditions that participating institutions must
meet. See id.; see also Ass'n of Private
Sector Colls. & Univs. v. Duncan (APSCU I),
681 F.3d 427, 435 (D.C. Cir. 2012) (“[S]chools receive
the benefit of accepting tuition payments from students
receiving federal financial aid, regardless of whether those
students are ultimately able to repay their loans. Therefore,
Congress codified statutory requirements in the HEA to ensure
against abuse by schools.”). Many of those conditions
center on the financial success of proprietary
institutions' graduates, because such success makes it
more likely that the borrower will repay his own loans.
See generally 20 U.S.C. § 1094. Under 20 U.S.C.
§ 1002(b)(1)(A), students at “proprietary
institutions of higher education” may receive federal
loan assistance only if their school “provides an
eligible program of training to prepare students for
gainful employment in a recognized
occupation.” See also Compl. ¶ 8, ECF No.
1 (emphasis added).

From
2009 to 2011, the DOE promulgated regulations defining the
term “gainful employment” (“GE”) in
terms of a debt-to-income test and a debt-repayment test.
See Program Integrity: Gainful Employment-Debt
Measures, 76 Fed. Reg. 34, 386 (June 13, 2011); see also
Ass'n of Private Colls. & Univs. v. Duncan, 870
F.Supp.2d 133, 153-54 (D.D.C. 2012). This Court determined
that parts of that rule were arbitrary and capricious under
the Administrative Procedure Act (“APA”). See
Ass'n of Private Colleges & Universities, 870
F.Supp.2d at 154, 158.

The DOE
again set out to define the term “gainful employment,
” this time focusing only on program graduates'
overall debt compared to their earnings, which it refers to
as “D/E” rates. See Program Integrity:
Gainful Employment, 79 Fed. Reg. 64, 890, 64, 891 (Oct. 31,
2014) (to be codified at 34 C.F.R. pt. 600, 668). “The
D/E rates measure evaluates the amount of debt (tuition and
fees and books, equipment, and supplies) students who
completed a GE program incurred to attend that program in
comparison to those same students' discretionary and
annual earnings after completing the program.”
Id.; see also 34 C.F.R. § 668.404.

The GE
regulations use two tests to determine whether programs
“pass, ” each of which is designed to determine
whether programs' graduates are earning enough income to
justify the government's guarantee of their loans. The
first test divides the program's graduates' average
loan payment amounts by their average discretionary income
amounts.[1] The resulting rate is called the
program's “discretionary income
rate.”[2] 34 C.F.R. §§ 668.402, 668.404. A
program passes if its graduates' loan payments make up,
on average, 20 percent or less of their overall discretionary
income. See 34 C.F.R. §§ 668.403. So, for
example, if a program's graduates were spending an
average of $200 per month on student loan payments, its
graduates' average monthly discretionary income would
have to be $1000 or more for the program to pass.

The
second test divides the program's graduates' average
annual loan payments by their average annual income. The
resulting rate is called the program's “annual
earnings rate.” §§ 668.402, 668.404. A
program passes if its graduates' average annual loan
payment is 8 percent or less of its graduates' average
annual earnings. See 34 C.F.R. § 668.403-04.
Using another example, if a program's graduates paid, on
average, $800 per year in student loans, they would need to
make an average of $10, 000 per year to pass.

A
program is classified as “failing” the GE
regulations if its discretionary income rate is greater than
30 percent and its annual earnings rate is more than
12 percent. Id. at § 668.403(c)(2). If a
program does not pass either test and its discretionary
income rate or its annual earnings rate falls in
between the passing and failing rates, then the school is
designated as “in the zone” between passing and
failing. See Id. § 668.403(c)(3); see
also 79 Fed. Reg. at 64, 891. A program loses HEA loan
eligibility if (1) it fails for two out of three consecutive
years, or (2) it is either in the zone or failing for four
consecutive years. 34 C.F.R. § 668.403(c)(4)(i)-(ii).

To
measure program graduates' income rates in calculating a
program's discretionary income rate or annual earnings
rate, the DOE presumptively uses income data from the Social
Security Administration. 34 C.F.R. §§ 668.405,
668.404(c)(1). The SSA data accounts only for earnings that
were reported to the IRS for the purpose of calculating
income tax. See 79 Fed. Reg. 64, 890.

If the
DOE's presumptive D/E rates, as calculated using SSA
data, would leave a program either failing or in the zone, it
may file an “alternate earnings appeal” to
request an alternative formulation to determine the
program's final D/E rates. 34 C.F.R. §§
668.406(a), 668.409(a)(5). This allows the school to argue
that more accurate data exists from which its graduates'
average level of earnings can be calculated. See Id.
§§ 668.406(b), 668.409(a). The process requires the
school to use either an institutional survey of the
institution's graduates or a state-sponsored data system,
if such a system exists. Id. § 668.406(b)(1).
The data generally must be from the same calendar year as the
SSA data that the DOE used to calculate the program's D/E
rate. Id. § 668.406(a). The state-sponsored
data-system avenue requires that the data include more than
50 percent of a program's graduates during the relevant
period. See Id. § 668.406(d). With limited
exceptions, the institutional-survey avenue requires a school
to obtain the earnings data of all of a program's
graduates during the relevant period.[3]Id. §
668.406(c). The DOE never explained how it came up with the
survey-response or state-based data requirements.
See 79 Fed. Reg. at 64, 995-96; see
generally 79 Fed. Reg. 64, 890. While an appeal is
pending, the school is not considered at risk of losing
eligibility the following year. 34 C.F.R. §
668.406(e)(2).

Notably,
if a program successfully appeals the DOE's use of SSA
data for the determination of its D/E rates, it can avoid any
negative repercussions altogether. Under 34 C.F.R. §
668.409(a)(1), the DOE's “final D/E rates”
can include either the presumptive SSA data or a
program's successfully proposed alternative. Only after
finalizing each program's D/E rate does the DOE finally
determine whether the program is passing, failing, or in the
zone. Id. § 668.409(a)(2).

However,
if a school does not timely appeal its designation or is
unsuccessful in seeking an alternative earnings calculation,
it begins to suffer serious consequences. Under the Gainful
Employment rules, schools that could lose HEA loan
eligibility the following year must provide written warnings
to current and prospective students informing them that their
“program has not passed standards established by the
U.S. Department of Education, ” and that if the
institution does not obtain a passing grade, the students may
not be able to receive federal student grants or loans the
following year. 34 C.F.R. § 668.410(a)(2)(i). The
warning requirement was implemented to protect prospective
students from programs that might put their loan eligibility
into jeopardy. See 79 Fed. Reg. at 64, 894. A
program becomes ineligible for federal student loans under
the HEA after failing the D/E rates for two out of three
consecutive years or by having a combination of failing and
in-the-zone rates for four consecutive years. See 34
C.F.R. § 668.403(c)(4)(i)-(ii).

Federal
courts have jurisdiction to review final agency action. 5
U.S.C. § 704. The APA requires reviewing courts to set
aside an agency action that is “arbitrary, capricious,
an abuse of discretion, or otherwise not in accordance with
law.” 5 U.S.C. § 706(2)(A). In cases like this
one, prior to final publication, the agency is required to
submit proposed regulations for a “notice and
comment” period, during which interested persons may
submit data and views to the agency for its consideration.
See 5 U.S.C. § 553.

III.
FACTUAL BACKGROUND

The
facts in this case are largely undisputed. Plaintiff, the
American Association of Cosmetology Schools brings this
action under the APA, seeking to enjoin the DOE from
enforcing its GE rules. Compl. at 1. AACS is a nonprofit
association of accredited cosmetology programs. Compl. ¶
1. At core, AACS takes issue with the DOE's use of the
SSA annual earnings data. See Compl. ¶¶
15, 35-38. Plaintiff notes that the SSA data is incomplete
because it tends to undercount the income of self-employed
individuals and individuals who receive a significant amount
of their income in the form of tips and cash. J.A. 797, ECF
No. 26-1; see also Decl. of Anthony Civitano
(“Civitano Decl.”) ¶¶ 25, 28, ECF
No.8-1. These two groups, the argument goes, can underreport
their income more easily than persons earning paychecks from
employer payrolls. J.A. 606; Civitano Decl. ¶ 28. Thus,
cosmetology school graduates-who Plaintiff claims are
disproportionately self-employed and paid in cash-on average
have higher incomes than the SSA's numbers reflect, in
many cases as much as double. J.A. 595, 787; Civitano Decl.
¶ 28.

According
to Plaintiff, the DOE was made aware of “this
well-known reported income gap phenomenon” by several
commenters during the notice-and-comment period of the GE
rule promulgation. Compl. ¶¶ 47-48. Indeed, the DOE
explicitly acknowledges that these comments included claims
that “about half of earnings in service occupations
such as cosmetology” are made up of tips, and that many
people in the industry are self-employed. See 79
Fed. Reg. at 64, 955. A report by Stanford professor Dr. Eric
Bettinger, which was submitted to the agency during the
notice-and-comment period, found that both tip income and
self-employment income are, on average, underreported by
around 60%. See J.A. 594; see also Decl. of
Katherine Brodie (“Brodie Decl.”) at 493, ECF No.
8-4.

Even
aside from formal public comments, AACS cites to several
sources suggesting that the underreporting of cash-based
earnings-including in the cosmetology industry-is widely
known to be a serious problem. See Brodie Decl.
¶ 3. For example, AACS provides the House Budget
Committee testimony of Russell George, Treasury Inspector
General of the Tax Administration, wherein Mr. George states
that “self-employed individuals who formally operate .
. . businesses . . . are estimated to report only about 68
percent of their income for tax purposes” and
“self-employed individuals operating businesses on a
cash basis report just 19 percent of their income to the
IRS.” Brodie Decl. at 1258. Although these materials
were apparently not submitted in connection with
notice-and-comment and have little direct relevance, they
lend credence to the general idea that the income gap
phenomenon is a significant problem.

The DOE
acknowledged that the use of SSA data was imperfect, but
generally viewed civil and criminal penalties as sufficient
deterrents to underreporting. See 79 Fed. Reg. at
64, 955-56. The pertinent portions of the DOE's responses
to the public comments are as follows:

We do not agree that our reliance on reported earnings is
flawed because of its treatment of self-employment earnings
and tips . . . . We acknowledge that some self-employed
individuals may fail to report, or underreport, their
earnings. However, [the Internal Revenue Code] requires
self-employed individuals to file a return if the individual
earns $400 or more for the taxable year. . . . Underreporting
subjects the individual to penalty or criminal prosecution. .
. .

With respect to the earnings of workers who regularly receive
tips for their services, [the Internal Revenue Code] requires
individuals to report to IRS their tip earnings for any month
in which those tips exceeded $20, and . . . individuals who
fail to do so are subject to penalties. . . .

For these reasons, we do not agree with the commenters'
assertion that aggregate earnings data provided by SSA . . .
are unreliable with respect to workers in occupations that
involve significant tip income or a high percentage of income
from self-employment. . . . Moreover, the regulations allow
an institution to submit an alternate earnings appeal using
State databases or a survey.

79 Fed. Reg. at 64, 955-56.

&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;At
least one commenter also proposed an alternate means of
calculating income. See id.; J.A. 53, 785; see
also Brodie Decl. at 1193-94. That commenter suggested
using data gathered by the Bureau of Labor Statistics, which
relies on population surveys rather than formally reported
income. See J.A. 597, 785; Brodie Decl. at 1193-94.
According to Dr. Bettinger, this data would more accurately
capture the earnings of, among others, cosmetology-school
graduates, because, unlike SSA data, it takes unreported
income into account. See Brodie Decl. at 684-85,
1193-94. “[T]hese adjustments would significantly
augment the SSA aggregate earnings reported for these
occupations, increasing the median earnings by 19 percent and
the mean earnings by 24 percent.” 79 Fed. Reg. at ...

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